I have written a couple of posts on how there is more gold paper than there is physical gold. A year ago, Adrian Douglas wrote that there were four owners for every ounce of physical gold that is traded. Recently, he told Peter Schiff that 45-100 times more gold paper exists than physical gold (see this post).
I concluded yesterday that banks which sell gold certificates do so on a fractional reserve basis. How can they dare take such risk? If the price of gold doubles, so would their liabilities! I was thinking about it after writing yesterday’s post. It is clear that the banks count on always being able to sell new certificates as their old customers begin to cash in the old ones. Thus, they count on an active trade in gold certificates and continue to make a profit on the premiums, as well as continue to lend out the proceeds from the sales. The Bank of Nova Scotia, which today has a market capital of 55 billion dollars, had 3.5 billion in Gold and silver certificates and bullion liabilities in their 2009 Annual Report. Now let’s imagine a scenario in which the majority of holders of gold certificates become anxious and therefore go to their banks and demand delivery of physical gold–a bank run–and that this happens not just in Canada to Scotia Bank but globally to all the sellers of paper gold. Suddenly a 3.5 billion dollar liability could become a 35 or even a 350 billion dollar liability, as banks scramble to buy physical gold, but suddenly gold becomes scarce instead of plentiful because no one is accepting the paper anymore. This is something that could bankrupt the banks–indeed, it is the classic means by which banks have bankrupted themselves. They issue more paper than what they have physical money, and people suddenly all come in to redeem their paper for real money (gold and silver). Some financial institutions have even charged their clients storage fees for the gold and silver that they were supposedly holding for them! (See e.g., regarding Morgan Stanley).
Now, perhaps an esteemed reader of this blog says to me, “The banks wouldn’t be that stupid.” But these are the same banks that bundled good and bad mortgages and sold them to the world in the form of derivative products called “CDOs”, saying that the housing market will never go down; this resulted in the sub-prime mortgage crisis and it has proven that banks are not run by the brightest people, but rather by immoral people whose desire to become rich leads to destruction and chaos.
The Righteous Investor 
How do you see this potentially being triggered? If the risk was so obvious wouldn’t a speculator try to attack the system?
I’m not sure the risk is obvious. Was the subprime mortgage crisis obvious? Bernanke told us the housing market was just fine. I did read a couple of sources that warned about it but I was unprepared for what happened. History is full of banks that wrote too much paper and didn’t have enough assets. Why does it happen over and over again? I wonder. To be sure at some point a speculator like Soros may try to bring down the system. He is perhaps still accumulating a position in preparation for just such an attack. I have no idea. But I don’t trust Soros–he trashes gold publicly while accumulating positions.
The trigger for the gold crash, if I were to guess, will be the onset of full-blown hyperinflation. I don’t think that hyperinflation is necessarily that far away. Gonzolo Lira suggests sometime in the new year. I am therefore increasing my gold positions: in mining companies I have positions in NGD, ABX, LSG and DGC. I’ve started buying physical gold (PHY.U); for the first time, as I do not consider gold to be an investment but rather a store of wealth. But on the chance that Adrian Douglas is correct, and paper gold far exceeds physical gold, I feel it is necessary to maintain a small position in physical gold. My small attempt to study a Canadian supplier of gold certificates, BNS, suggests that the banks are playing with fire.
What are your thoughts?
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Honestly I don’t know. On one hand you see trillions of derivatives out there and you see the banks and the governments playing with fire… and on the other hand, you see people that are unwilling to be duped by low interest rates into living beyond their means. Where does this end, and how do the malinvestments finally evaporate? I don’t know. I’m still learning about this and reading a lot.
One thing to watch out for is that the government ignores inflation when calculating tax. If your gold goes to $9,000 an ounce… the government is going to want its share if you try to exchange that for something else. If in real terms gold kept its value, then in real terms you lose after paying said tax.
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The price of Gold could be $10,000 per ounce if the Federal Reserve keeps the printing presses running.
In fact I have a video on my blog “The Day the Dollar Died” that gives an idea of what could happen.
It is really scary!